After the FTSE 100’s 37 per cent return, should I still invest?

I am an investment writer at Schroders, having previously worked as a journalist at the BBC and Reuters.

The Brexit verdict had a large impact on returns from the FTSE 100 in 2016 (Source: Getty)

David Brett

The rise in the FTSE 100 since a low last February has been remarkable. The index was up 33% between 11 February 2016 and mid-January 2017. Including dividends, the index returned 37%.

The index also recorded a fresh all time high during that period, reaching 7,337.81 on 13 January 2017.

Stocks in certain sectors led the market higher, including mining, basic materials, energy firms and industrials. Some sectors rose more than 130%.

Valuations were up sharply too. Many of the FTSE’s sectors are now valued above their long-term averages.

With the index and its constituents enjoying such large gains, should you still consider investing in the FTSE 100?

What happened to the FTSE 100 in 2016?

In the calendar year of 2016, the FTSE 100 gained 14%. It was the largest increase since 2009 when the index climbed 22%, but that was not the main story.

When concerns about China gather paced early in the year, due to the country’s level of debt, global markets wobbled. The FTSE 100 hit a 2016 low on 11 February.

However, from that point to the end of a record-breaking 14-day run on 13 January 2017 the FTSE 100 rallied 33%.

Dollar earners, such as miners and energy companies, were the big gainers. They were helped by a weaker pound as a result of Brexit, as well as pro-trade, pro-inflationary policies in the US and China.

In contrast “safer” stocks with bond-like characteristics, often called “bond proxies”, all underperformed. These shares tend to have sustainable income yield, low volatility and consistent growth characteristics.

How has the FTSE rally affected valuations?

Before the FTSE rally began in earnest in February 2016 only one sector – consumer discretionary – traded above its long-term (10-year) average on a key measure of valuation known as CAPE.

CAPE, or cyclically-adjusted price to earnings ratio, is essentially an enhanced version of the more widely used price-to-earnings ratio or P/E. CAPE compares a company’s share price today with its 10 years of averaged earnings, adjusted for inflation. Taking profits over a decade helps smooth distortions created by the business cycle. This is particularly appropriate over the last decade given the impact of the financial crisis.

If a share, sector or index has a CAPE below its long-term average then it might be considered good value, or at least it is better value than it has been historically. As with a P/E ratio, lower numbers suggest better value.

The table below shows the average CAPE for each sector over 10 years and compares the figure today (January 2017) with a year ago and 10 years ago.

Bond proxies such as healthcare and consumer staples now look relatively expensive compared with their valuations in February 2016.

Telecoms, utilities, basic materials, oil and gas and mining sectors, on the other hand, are still valued below their long-term (10-year) CAPE, despite their recent gains.

As the table below illustrates, ahead of the financial crisis many of the FTSE sector valuations were above their 10-year average CAPE. By February 2016 that had almost completely reversed. By January 2017, most sectors were back above their long-term average.

So, should I still invest in the FTSE 100?

Clearly there are risks investing in stock markets at all time highs, but there are risks in not being invested too and few appealing alternatives.

Interest rates remain at near historic lows. The yield on bonds also remains low and prices have fallen in recent months. Stock markets still have the potential to provide an inflation beating return over the long-term, albeit with risk attached.

As the data above shows, even in times of turbulence, there are sectors within the stock market which do gain.

But it is about picking the right sectors and the right stocks within those sectors; evaluating which companies are cheap for a good reason and which companies are genuinely undervalued.

Once those stocks and sectors have been identified it is then up to the companies to deliver – there are no guarantees.

David Docherty, Schroders’ UK Equities Fund Manager, said: “We look for opportunities in sectors such as banks and construction, while maintaining a cautious view on utilities and real estate.

"There are any number of risks to consider in the year ahead: the eurozone electoral timetable, Brexit, China’s economy and global monetary policy as investors digest inflation and activity indicators.

"On balance, however, we believe that the narrative which emerged in 2016 of a normalisation of government bond yields, inflation, growth and monetary policy will continue to inform markets in 2017.

"The new investment environment has continued longevity.”

Should I try to time investing in the market?

Trying to move in and out of markets, to call the top and the bottom, is exceptionally difficult. And, if you get your timing wrong, this can have a damaging effect on returns.

Consider this example. If you had invested in a basket of global equities investments in global stockmarkets - the MSCI World index - between 2005 and 2015 you would have received a return of 60%. But if you missed the 10 best days within that period then you would have lost 5%, according to Financial Express data compiled by Schroders. It’s an extreme example but demonstrates the risks of trying to time markets.

The lesson from history is to keep your nerve at times of turbulence. The data also highlights the merits of long-term investing.

The timeframe of five years is usually suggested as the minimum for stock market investment on the basis this allows investors to experience the ups and downs of a normal market cycle; though, as ever with investment, nothing is guaranteed.

James Rainbow, Co-Head of Schroders’ UK Intermediary Business, said: “Investors who try to time the top and bottom of the market do so at their peril. At the very least, it is difficult to do on a consistent basis, if not impossible.

“Markets can turn on a dime, seemingly for little reason, as we saw in the wake of Trump’s election. Costs associated with continually entering and exiting the market can mount too.

“A far better approach is to think long-term; make sure you have a clear investment plan and stick to it, which helps smooth out those short-term shocks.

“Block out the noise and keep your head, particularly when markets move against you.”

Please remember that past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

Important Information: The views and opinions contained herein are those of David Brett, Investment Writer, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.